Understanding Surrender Value in Life Insurance

Surrender Value in Life Insurance - Explained

Surrender value in life insurance refers to the sum that a policyholder is entitled to receive when he or she cancels his or her insurance policy before it reaches the end of its maturity period.
In simpler terms, surrender value refers to the amount of money that the policyholder shall receive at the time of cancellation of the insurance policy.

This article will dive into what surrender value entails, how surrender values are calculated, and what financial effects come with surrendering a policy.

What is Surrender Value and Why Does it Matter?

Surrender value is of utmost importance to policyholders to make a sound financial decision about their respective insurance policies irrespective of whether they are starting one or choosing to close one before maturity.

Here’s why it is important:

1. Liquidity:

The knowledge of surrender value indicates the extent of liquidity from the policy proceeds that would become available to the policyholder if the policy is prematurely cancelled. In some instances, policyholders might consider the sum received as immediate financial aid in case of emergencies.

2. Knowing about the value of the policy:

In case you need to liquidate a policy early, it's essential to understand the value of the policy at that point since closing the policy would mean it does not continue for the original duration with the original benefits. Knowing the surrender value is hence essential to making a financially informed decision.

3. Impact on Financial Planning:

It impacts long-term financial planning and retirement strategies if the policy is designed to be part of a large investment plan.

What are the Types of Surrender Values?

Insurance policies can provide an array of surrender values based on the terms and conditions of the policies. These can be summarized with the help of the following key types:

• Guaranteed Surrender Value (GSV)

This is the minimum amount a policyholder will receive on surrendering the policy, which can be claimed subject to certain terms and conditions. The GSV is usually calculated as a percentage of the total amounts paid as premiums, minus all applicable charges.

Example: If you have a life insurance policy for which the GSV is 30%, and you have paid ₹1,00,000 on premiums, your guaranteed surrender value would be ₹30,000, subject to any other deductions applicable on the premium paid.

• Special Surrender Value (SSV)

This is a benefit provided by certain policies wherein a higher surrender value is offered beyond the GSV. SSV is usually a higher value than the GSV, and its payment is typically made subject to specific terms and conditions. Special Surrender Value is more than GSV and is at the discretion of the insurance company based on specific plan details. This is also calculated based on the performance of the funds that the policy is invested in along with with bonus or interest earned until that time.

Example: For the same example mentioned in GSV, if the insurance company is providing an SSV of 40%, the special surrender value will be ₹ 40,000.

How is the Surrender Value Calculated?

Surrender value calculation depends on some factors:

1. Premiums Paid: Amount of premiums paid to the policy.
2. Policy Term: The period for which your term insurance policy will remain active, this is selected and fixed at the time of purchasing the plan.
3. Bonuses or Interest: If there are bonuses or interest that are included in the policy that one is eligible for at the time of surrender of the policy. 
4. Deductions: Surrender charges or penalty if any charged by the insurance company on the policy value due to pre-closure.

Do All Life Insurance Policies Offer Surrender Value If You Cancel?

No, not all policies have a surrender value upon cancellation. The policy surrender value depends upon the kind of insurance policy.

• Permanent Insurance Surrender Value

Most permanent forms of life insurance like whole life or end policies carry a surrender value. Such policies normally accumulate some cash value over time, which may be accessed if the policyholder decides to surrender the policy.

• Term Insurance Surrender Value

Term policies usually do not have a surrender value. Term insurance policies pay through a term and cannot earn cash value. Hence, surrendering a term policy usually brings no monetary benefit.

When Does Surrender Value Become Available?

Surrender value becomes available usually after a certain period, referred to as the "lock-in period," in which the policy cannot be surrendered. This varies from one policy to another but is typically in a time frame between 1 to 3 years.

Example: If the lock-in period in your policy is 2 years, it means that you will have access to the surrender value only after 2 years from the policy commencement.

Financial Impact of Surrendering Your Policy

When you prematurely cancel or close your policy, you may incur some loss in value in relation to the originally planned maturity value. The surrender value indicates to you the exact gap between original plan value and the sum you would receive on premature closure. 

Pros (Short-term Benefits)

1. Flexibility: Surrender Value brings in an element of flexibility to life insurance. One can be assured that in case circumstances change and one has to end the plan, there is some surrender value to get in hand even if plan does not continue as originally planned.

Cons (Long-term Drawbacks)

1. Loss Coverage: You give up the insurance coverage during surrender which means you lose the originally intended coverage.
2. Potential Loss in Return Value: It is possible, based on the plan and investment growth that the surrender value might be lesser than the sum or cumulative amounts one would have paid for the premium until then. 

Why Do People Stop Paying For Life Insurance?

Here are some reasons to make one surrender their policy:  

1. Financial Need: Inability to pay the premium because of emergency expenses or loss of a source of income.
2. Policy Dissatisfaction: The policy does not meet the changing needs or expectations.

What happens if the policyholder stops paying the plan’s premium amount?

When you stop paying for your life insurance:

1. Grace Period: Most policies have a grace period (typically 30 days) during which you can still pay overdue premiums without losing coverage.
2. Policy Lapse: If you do not pay premiums in time, then the policy would lapse. This means that the coverage and benefits from the plan would end. Based on the plan, you would only get a partial amount as surrender value is available.

What to Know About Taxes and Surrendered Policies?

Tax Consequences of Surrendering an Insurance Policy

1. Taxable Income: The amount you receive in a surrender value may be taxable based on the kind of policy and its value.
2. Tax Benefit: Policy premiums are generally tax-deductible; when a plan is cancelled you would not pay future premiums and must consider the change in your taxable income due to this and seek suitable alternatives for tax planning. 

Tips to Using Surrender Value Effectively

1. Needs to be Evaluated: Consider the present financial needs and future objectives before surrendering.
2. Seek a Financial Advisor: To know how it affects you financially and possibly measure alternatives.
3. Alternatives: Consider the option of taking a loan against the cash value or getting the policy converted into reduced paid-up insurance.

Making the Right Choice: Factors to Consider Before Surrendering

1. Current Financial Situation: Weigh your short-term and long-term financial needs.
2. Policy Value: Calculate the surrender value in relation to the value that the policy would likely provide if left untouched until maturity or end of the plan period. 
3. Alternatives: Explore alternative options for cash requirements if not through the surrender value. For example, some plans may allow you to draw an OD or loan against the fund value or policy amount. 

When is the Right Time to Surrender Your Policy?

You must surrender your policy in the following scenarios:

1. When requiring immediate financial assistance.
2. The policy does not match your requirements due to revised financial goals.
3. Identification of better alternatives in the form of investment plans or insurance policies that provide better returns or coverage, respectively.

Beyond Surrender: Options to Consider

If you decide you want to cancel your policy, there are a few options:

1. You can borrow against the cash value: That way, you'll be able to access the funds without having to give up the policy.
2. Reduced Paid-Up Insurance: This will result in having your insurance policy change to the extent of premiums paid-up until this point, which means a drop in the benefit value. The advantage however is that you don’t have to pay a premium anymore, reducing the ongoing and future commitment if that is causing a concern and there is no urgent need or alternative investment option for the funds.
3. Converting to term insurance: You can use your policy as the basis for a new term life insurance plan, but based on the decreased premiums and reduced amount of death coverage.
4. Partial Withdrawal: Some policies even permit for partial withdrawal from the cash value, allowing the plan to stay in force even with some reduction in coverage or benefits. 

Conclusion

The attempt to surrender value as the solution can only solve your need if there is a clear understanding of the feature. It is only to be considered in case of a financial crunch or while re-evaluating the present insurance needs after exhausting other alternatives. It will help you make the best decision based on your situation and needs in an informed manner.

Consider seeking a financial advisor's opinion before making your final decision, as they should be able to clarify any implications and potential alternatives that better align with your long-term objectives.

Shriram Life Insurance provides a wide range of Life Insurance Policies to suit different financial goals of individuals. By ensuring financial stability and peace of mind, Shriram Life Insurance plans help people navigate their financial milestones and manage their risks with confidence.

For more information on insurance plans, visit our pages on Retirement Plans, Savings Plans, and Protection Plans.